In the weeks leading up to the election, analysts were predicting a Trump win would cause panic in the stock market. Investors would sell out of stocks because of the uncertainty of what a Trump presidency would look like. When the FBI reopened their investigation into the Clinton email scandal just eleven days prior to the election, we saw the stock market drop as quickly as Clinton’s big lead in the polls. Then, just a week later, the FBI oddly announced there was nothing doing with the reopened investigation. The stock market climbed upon hearing this news as it looked like a Clinton presidency was imminent.
As we now know, the polls missed the mark, and Trump won the election. What is really odd though, is how the stock market has reacted since he won. The market activity leading up to the election suggested that investors feared a Trump presidency. Investors confirmed this during after hours trading on the night of the election as the Dow dropped nearly 800 points at one point when it looked like a Trump presidency was becoming a reality. None of this was unusual as Trump represents change to the establishment. Change creates uncertainty, which leads to an emotional reaction of selling off stocks in the short-term.
After the election results became clear, however, the stock market did something unexpected. It stabilized and then saw a huge rally on Wednesday that led into Thursday and saw the Dow hit an all time high. Even more odd is that post-election market rallies have only occurred in 6 of the last 21 elections. If you predicted all this market movement, then you truly are an investing savant!
The past two weeks have shown just how unpredictable the market can be in the short-term. As an investor, this recent rally has been nice, but many still see potential trouble for the market ahead. As of now, the markets are reacting to the policy changes promised during Trump’s campaign. Policy changes that would lead to less regulation and a more business friendly environment. However, the details of many of these policy changes has yet to be released. The ideas seem good on the surface for business, but the long-term impact of these policy changes has yet to be seen, and yet to be built into the market.
With that, investors are still cautious about the future of the stock market. Regardless of who won the election, many investors feel that the market is overvalued. Further, they believe that after a bull market of 8 years now, we are due for a correction (how long have they been saying that now?). Additionally, if Trump gets his way and the Fed begins to raise interest rates on a regular basis, how will the economy perform in a rising rate environment? There are many issues to be concerned with, but does this change your investing strategy?
Timing the Stock Market
Timing the market is one of the most difficult things you can try to do. Think about the current bull market that is still going. How long have people been predicting a correction now? I remember as far back as 2012 people were saying we were due for a correction. Think if back in 2012, with the impact of the Great Recession still fresh in your mind, you would have pulled your money out of the stock market. “This bull run can’t last forever,” you reason. You would have missed a banner year in 2013 with returns of 32.15%. How about 2014? The S&P returned 13.52% that year. Surely it can’t last into 2015, right? The market didn’t perform nearly as well last year, but the S&P 500 was still up 1.36%. The positive trends in the market continue into 2016, for now at least.
The problem with timing the market is investors don’t always make rational decisions. It’s similar to playing poker against a novice. You could play a hand perfectly, and a more experienced player would realize they’re beat and fold. The novice plays more on emotion though. They stay in the hand at the small chance of winning a big pot, because their emotions tell them, “what if I fold and it’s that one time my card comes to make my hand?” The point being that novice poker players are unpredictable as they make irrational decisions based on emotion.
The stock market is the same way. It’s impossible to predict in the short-term because despite valuations and earning reports and a number of other factors that reason the market should go one way or the other, imperfect humans are the ones left to make the decisions to buy, sell, or hold. As we all know, sometimes we let emotion get in the way of making the best decision.
Coping With Market Volatility
Implementing a buy and hold strategy through dollar cost averaging is easy when the market is going up. It’s much more difficult though when the market is dropping like a rock. When the market began to collapse back in late 2007, I was just two years out of college. I had enough sense at the time to know I needed to stay invested. History shows the market will bounce back, it’s just a matter of when. This was easy for me at the time, though. Being fresh into the workforce, I only had about $20,000 invested in the market. It was a lot easier for me to stay the course than someone with 20-30 times that amount.
I remember one person in particular whom I worked with at the time. He was a partner who undoubtedly had significantly more invested in the market than I did when the market came tumbling down. He talked about how he pulled all of his money out of the market and put it into cash. This was late 2008, with the market already down about 30%. He reasoned this time was different. We might not recover this time. He had bought into the fear that the media was feeding him. The media that has a very short-term outlook and is more focused on gaining viewers than offering sound investment advice for the long-term.
This shocked me at the time. How does someone with such good business sense, with a background in finance and accounting, make such poor investment decisions? The answer is fear. Much like the novice poker player, he was making decisions based on emotion. Decisions that let to him selling low and then buying high when he eventually came back into the market.
Time in the Market vs. Timing the Market
The problem with trying to time the market is that many investors are slow to recognize a retreating stock market. Likewise, many also fail to see an upward trend in the market until they have missed the opportunities for gains. Consider that in the 12 months following the end of a bear market, a fully invested stock portfolio has an average total return of 37.4%. However, if an investor missed the first six months of the recovery by holding cash, their return would have been only 7.5% (Source: 2015 Ned Davis Research Group). As you can see, there is considerable risk to your portfolio if you exit and enter the market at the wrong time.
A better approach, is using a buy and hold strategy, and entering the market through dollar cost averaging. Using this method takes all of the emotion out of the decision making process. This also ensures you won’t be missing the best days in the market, as the partner I worked with did.
Why is this important? The chart below from Business Insider shows the impact of missing the best days in the market during the 20 years ended December 31, 2013. Missing just 10 of the best days over a 20 year period (over 5,000 trading days) will nearly cut your annualized returns in half! How good is your crystal ball?
Recommendations for Successful Investing
- Automate – If you have a 401k, the automation is already set up. Twice a month or every two weeks, money is taken out of your paycheck and invested into your 401k. Set up the same automatic investing schedule for your after tax accounts. If you get paid every two weeks, create an automatic deposit into your investment account for every two weeks. This is what I do when investing in Wealthfront, and it allows me to dollar cost average into the market.
- Tune Out the Noise – There are hundreds of media sources out there focusing on investing. Your best bet is to ignore them. These sources are all about the short-term. None of them promote the virtues of long-term buy and hold strategies because, well, that’s boring. Investors like to fantasize about hitting a 10 bagger in the market and then bragging to all their friends about how smart they are. Set aside a small portion of your portfolio for this, but don’t make it your overall strategy.
- Diversify – Keep your portfolio diversified across US sectors and allocated to the proper investment types based on your risk tolerance and investment timeline. There are numerous tools available to help you analyze the current allocation of your portfolio. I use the free tools at Personal Capital for this.
These three rules will help you focus on the long-term and ignore the short-term volatility that comes with investing in the stock market.
Readers, what is your outlook for the future now that the election has been decided? What are your strategies for long-term success in the stock market?